(Bloomberg) — Before Sam Bankman-Fried was arrested in the Bahamas and charged with fraud this week, and before the demise of a $60 billion crypto ecosystem decimated digital asset lenders in May, there was the industry’s original bogeyman: Tether.
A handful of hedge funds are now turning their focus back to the $66 billion stablecoin, which they warn could be the next crypto catastrophe — one that would make the implosion of Bankman-Fried’s FTX exchange look small in comparison.
Fir Tree Capital Management and Viceroy Research are among the firms shorting Tether, according to people familiar with their wagers — positions they’ve held for months, waiting to cash in on their bets.
Those in the trade — and those interested — argue the payoff could be fast approaching as the turmoil in the crypto market could push Tether’s value below its promised 1-to-1 exchange rate with the dollar. Among the other reasons: US Attorney Damian Williams, who is leading the case against Bankman-Fried, also recently took over a probe into Tether and whether executives behind the stablecoin committed a crime.
Even so, the short is hardly straightforward. Valiant, a San Francisco-based hedge fund, made the trade earlier this year, but backed away and made it out unscathed, according to people familiar with the matter. The fund would consider shorting Tether again if it could do so without risking collateral, the people said.
Philippe Laffont’s Coatue Management and other funds looked at the trade and also passed due to counterparty risk, according to people familiar with the matter.
“I’m not short Tether – I haven’t found the vehicle,” said Andrew Left, founder of Citron Research, a short seller. “If someone showed me a way to do it with Goldman Sachs as a counterparty, I’m in.”
Left said he’s short the world’s second-largest cryptocurrency, Ether, which has a well-regulated futures contract, but declined to comment on the size of the position.
Representatives for Fir Tree, Viceroy, Valiant and Coatue declined to comment.
Tether, the world’s third-most traded token, is considered the backbone of the crypto ecosystem, even though the stability of its exchange rate with the dollar has been questioned repeatedly since it began in 2014.
Its executives — including former plastic surgeon Giancarlo Devasini — haven’t put those doubts to rest. Tether and sister exchange Bitfinex agreed to pay more than $60 million to settle allegations that it misled investors about its reserves.
Yet Tether persists, even thrives, despite its unaudited financials — carrying on a high-stakes game of chicken with the crypto industry.
Coin Cracks
Some crypto leaders argue Tether is too big to fail without putting the entire $870 billion market at risk.
In a sign of its importance, Bankman-Fried’s rival, Binance’s Changpeng “CZ” Zhao, sent him messages before FTX’s bankruptcy urging him not to drive down Tether’s price, according to testimony Bankman-Fried prepared for a Congressional hearing before his arrest. He denied that he ever tried to manipulate the stablecoin’s price.
Tether sent about $37 billion of its token to Alameda Research through late last year, according to Protos, making the trading firm its biggest client.
As panic over FTX spread in early November, Tether fell as low as 96.35 cents, before recovering. A crack — and one of its biggest to date — but not a breaking of the dam.
“If Tether goes down, it is not unrealistic to imagine that cryptocurrencies fall by 50%,” said Chris Solarz, chief investment officer of digital assets at Forest Road Co. “That’s true systemic risk.”
Critics have long argued that Tether Holdings doesn’t have enough high-quality, liquid assets for its stablecoin to be worth a guaranteed $1. Others fret Tether is used for illicit activities, like gambling in places where it’s illegal.
“This is yet another ridiculous attempt to tarnish the reputation of Tether with inaccurate and baseless claims,” a Tether spokesperson wrote in an email. “The obsession over Tether is what led Bloomberg and many other media outlets to overlook the real bad actors in this industry.”
Perfect Short
Shorting Tether — either by borrowing the stablecoin and selling it, hoping to buy back later at a lower price, or through swaps — can serve as a hedge against long crypto bets or an outright wager against the token.
Crypto lender Genesis, which told investors it may need to seek bankruptcy in the wake of FTX’s collapse, is among the brokers that allowed customers to bet against Tether.
In theory, it’s the perfect short — a classic asymmetric trade. It can’t rocket to the moon like a meme stock because it’s capped at $1, meaning losses should be limited to the cost of putting on the trade. The payoff, though, could be huge if there’s a run on the bank. If reserves don’t equal outstanding Tether, then investors who are last to redeem might get nothing.
Tether and other stablecoins were created to make it easier for traders to move in and out of volatile tokens. Despite questions around it, people continue to use Tether because it offers features its competitors don’t. It can be exchanged — or paired — with more cryptocurrencies than other stablecoins, and it isn’t based in the US — a big appeal to crypto traders globally.
Speculators aren’t the only ones who depend on it. The token has become a cheaper and faster replacement for Western Union, a way for foreign workers to send money home instantaneously.
Still, Tether hasn’t been immune to the steep losses across the crypto industry. About $16 billion has been redeemed since the end of March, when the outstanding amount reached $82 billion.
FTX Links
Meanwhile, Tether’s skeptics are scouring for links between the stablecoin and FTX.
Alameda, FTX’s trading firm, injected $11.5 million into tiny Moonstone Bank through the firm’s parent company, FBH Corp., earlier this year. FBH’s chairman is Jean Chalopin — who also chairs Bahamas-based Deltec Bank, which counts Tether as a client.
Moonstone, based in Washington state, said in a statement after FTX’s collapse that it was completely separate from Deltec and that Alameda had no board memberships or involvement with management.
A pair of lawyers who work for the companies, Dan Friedberg from FTX and Stuart Hoegner from Tether, had previous ties to Ultimate Bet, a poker site that authorities caught in a cheating scandal — a link one participant made in prepared testimony for a Senate Banking Committee hearing on Wednesday.
On Nov. 10, as FTX was imploding, Alameda borrowed $1.8 million of Tether, a trade visible on the blockchain.
In their exchange, Zhao reached out to Bankman-Fried telling him to “stop trying to depeg stablecoins,” something the FTX founder suggested was impossible to do without putting a lot of money at risk.
“Are you claiming that you think that $250k of USDT trading would depeg it?” Bankman-Fried asked, using another name for Tether.
“No, I don’t think 100x that size will succeed,” Zhao shot back. It just causes “small issues here and there.”
FTX and other firms folding “can be attributed to bad business, bad leadership, poor management, bad loans, and bad collateral none of which has anything to do with Tether,” the Tether spokesperson said.
Open Question
Still, Tether’s reserves remain the largest open question.
Tether concealed the loss of more than $850 million of reserves to a Panamanian entity called Crypto Capital Corp. as recently as 2018, the New York Attorney General found. In a separate case, the Commodity Futures Trading Commission found Tether didn’t have enough fiat reserves to back circulating tokens more than two-thirds of the time, in a period between 2016 and 2018.
Though it’s promised to undergo an audit for years, Tether has never produced one — nor anything more than quarterly “transparency updates.” It has had six accountants since 2017, and has said the big four firms have balked at taking it as a client because of liability issues.
Some potential short sellers want more proof that the stablecoin is on shaky ground. Hindenburg Research last year promised a bounty of up to $1 million for anyone who could produce information on Tether and the assets backing it.
Tether’s attestation for Sept. 30 says roughly 18% of its reserves, or almost $12 billion, were in assets other than cash or cash equivalents: corporate bonds, funds and precious metals, secured loans and an “other investments” category.
Reducing Lending
Some of those mystery assets include stakes in crypto companies and loans to entities that have been caught up in the industry’s meltdown, according to investors who have studied the token.
Tether said Tuesday that it would steadily reduce its practice of lending out funds from its reserves and look to stop the activity in 2023.
“I don’t know why anyone would trust any of their financial attestations at this point,” said John Griffin, a professor at the University of Texas who works on forensic finance and has spent more than a decade looking at illicit corners of the financial system.
“If they are fully backed, you could just put all that money in Treasuries,” he said.
Though Tether didn’t arrange an interview with any executives, its co-founder Reeve Collins reached out to Bloomberg via a spokeswoman to discuss FTX’s collapse and his career at Tether, which spanned 2013 to 2015.
He arrived to a December Zoom meeting a few minutes late, video camera off, and mentioned he was in Miami for Art Basel and crypto conferences.
Asked how FTX’s downfall would affect the token, he said it meant nothing, just like the years-long concerns of regulators, journalists and anonymous Twitter accounts.
“It’s always a dollar,” he said. “To me, it’s rock solid.”
–With assistance from Emily Nicolle and Hema Parmar.
More stories like this are available on bloomberg.com
©2022 Bloomberg L.P.
